As part of its phased approach to regulation of cryptoassets, His Majesty's Treasury (HMT) has legislated to bring 'qualifying cryptoassets' within scope of the UK financial promotions regime (the Regime). In June 2023, the Financial Conduct Authority (FCA) published its final Policy Statement setting out the new financial promotion rules in respect of cryptoassets, which are largely consistent with the financial promotion rules for other high-risk investments.
These new rules come into force on 8 October 2023 and apply to all firms marketing cryptoassets to UK consumers, including firms based overseas. In this insight, we summarise the key rules and the consequences of a failure to comply.
Which cryptoasset promotions will be in scope of the Regime?
Financial promotions of qualifying cryptoassets will be subject to the Regime from 8 October 2023. Broadly speaking, a 'qualifying cryptoasset' is any cryptographically secured digital representation of value or contractual rights that is transferable and fungible, but does not include cryptoassets that meet the definition of electronic money or an existing controlled investment. Therefore, non-fungible tokens (NFTs) will remain outside of the Regime, leaving the advertising oversight of these to the responsibility of the Advertising Standards Authority.
The Government has amended the following controlled activities related to the buying and selling of investments to include reference to qualifying cryptoassets. This means that invitations or inducements to engage in the following activities (Financial Promotions) in relation to qualifying cryptoassets will be within the scope of the Regime:
- dealing in securities and contractually-based investments;
- arranging deals in investments;
- managing investments;
- advising on investments; and
- agreement to carry on specified kinds of activity.
What does this mean practically?
Anyone who issues a Financial Promotion unlawfully will be guilty of a criminal offence.
Anyone who wishes to issue a Financial Promotion in respect of a qualifying cryptoasset in the UK will only be able to do so legally where:
- the Financial Promotion is communicated by an authorised person;
- the Financial Promotion is made by an unauthorised person, but is approved by an authorised person;
- the Financial Promotion is communicated by (or on behalf of) a cryptoasset business that is registered with the FCA for anti-money laundering purposes; or
- the Financial Promotion is otherwise communicated in compliance with the conditions of an exemption under the Financial Promotions Order (the FPO).
Existing exemptions in the FPO will generally apply to Financial Promotions of qualifying cryptoassets in line with their existing scopes. This means that the well-known exemptions for high net worth individuals and self-certified sophisticated investors will not apply to Financial Promotions of qualifying cryptoassets. This is determined on the basis that these only apply to promotions relating to a specific set of controlled investments set out in existing legislation which broadly relate to unlisted securities.
Financial Promotions in relation to qualifying cryptoassets which are not issued using one of the four routes listed above, will be in breach of the financial promotion restriction set out in section 21 of FSMA (the Financial Promotion Restriction). Such a breach is a criminal offence, punishable by up to two years' imprisonment, the imposition of a fine, or both.
Financial Promotions of Qualifying Cryptoassets must comply with the FCA's Financial Promotion Rules for High Risk Investments.
As from 8 October 2023, qualifying cryptoassets will be categorised as 'Restricted Mass Market Investments' for the purposes of the FCA's financial promotion rules (the Rules), allowing them to be mass marketed to consumers, subject to certain restrictions:
- Clear, fair and not misleading financial promotions with adequate risk warnings - all Financial Promotions will be subject to the FCA's rules on being 'fair, clear and not misleading' and must contain a prominent and standardised risk warning in a format prescribed by the Rules. The risk warning to be used in respect of qualifying cryptoassets is as follows:
Don't invest unless you're prepared to lose all the money you invest. This is a high-risk investment and you should not expect to be more protected if something goes wrong. Take 2 mins to learn more.
The 'Take 2 mins to learn more' text should comprise a link which takes readers to a risk summary that relates specifically to the risks of the particular cryptoasset being promoted. The risk summary should be in consumer-friendly language and take no more than 2 minutes to read.
- Ban on incentives to invest - monetary and non-monetary benefits that incentivise investment activity, such as 'refer a friend' or new joiner bonuses, are banned under the Rules. The FCA considers that incentives to invest can unduly influence consumers' investment decisions and cause them to invest without fully considering the risks involved. This only captures non-intrinsic incentives, i.e. benefits that are not intrinsic to the cryptoasset or exclusively bound up with its function or business model.
- Cooling off period - first-time investors with a firm must be given a 24-hour cooling-off period, meaning that a consumer cannot receive a 'Direct Offer Financial Promotion' (DOFP) unless they reconfirm their request to proceed after waiting at least 24 hours.
Generally speaking, a DOFP arises where the Financial Promotion specifies the manner of response or includes a form by which any response may be made. The cooling off provision for first-time investors with a firm is intended to ensure that extra protections exist before consumers are in a position to take the crucial step towards placing their money in the investment. However, during this period, firms can carry out other aspects of the on-boarding process, such as completing AML/KYC checks, showing the personalised risk warning, undertaking client categorisation and carrying out an appropriateness assessment (see further below).
The 24-hour cooling off period starts from when the consumer requests to view the DOFP. Firms must not show the DOFP until at least 24 hours have elapsed following the consumer's request.
- Personalised risk warnings - first-time investors with a firm must be shown a personalised risk warning pop-up (or equivalent) before a DOFP can be communicated as follows:
[Client name], this is a high-risk investment. How would you feel if you lost the money you're about to invest? Take 2 min to learn more
The personalised risk warning must comply with the FCA's detailed prominence requirements and the 'Take 2 min to learn more' must link to the same product-specific risk summary, as in the main risk warning. Where the Financial Promotion does not appear on a digital medium, firms will need to provide the personalised risk warning to the consumer, accompanied by the risk summary, in a durable medium.
- Client categorisation - before a DOFP can be made in relation to a qualifying cryptoasset, the consumer must be categorised as a restricted, high net worth or certified sophisticated investor, with the conditions for each category (which are set out in the Rules) being satisfied. Firms should remember that the investor classifications are valid only for a 12-month period to account for changes in life circumstances and will need to re-categorise consumers after expiry of the 12-month period if they wish to make further DOFPs. If a consumer cannot be categorised as a restricted, high net worth or certified sophisticated investor, then the DOFP must not be communicated to the consumer.
- Appropriateness assessment - before an application for investment into a cryptoasset can be processed in response to a DOFP, firms must assess the specific cryptoasset as appropriate for the consumer. This requires the firm to assess that the consumer has the necessary experience and knowledge to understand the risks involved in relation to the specific cryptoasset offered or demanded. The FCA will be updating its guidance on the types of baseline questions to be covered by an appropriateness assessment in respect of cryptoassets. However, firms should note that they may need to ask additional or alternative questions to ensure that the retail client has the necessary knowledge to understand the risks involved in the specific type of cryptoasset offered.
- Record-keeping - firms must record the outcome of:
- client categorisation (i.e. the number of consumers categorised as high net worth, sophisticated and restricted and the reason why they believe they meet those criteria); and
- the outcome of the appropriateness assessment (i.e. the final outcome of the appropriateness assessment for each consumer and the number of times they were subject to the assessment for the same investment, the number of assessments that determined the investment to be appropriate and inappropriate, and the total number of assessments undertaken).
Beware FCA enforcement action
Financial Promotions in relation to qualifying cryptoassets must be issued lawfully and comply with the relevant Financial Promotion rules for high risk investments from 8 October. This applies to anyone promoting cryptoassets to UK consumers, including firms based overseas.
The FCA has recently issued a final warning that if unregistered cryptoasset firms continue to promote cryptoassets to UK consumers once the Regime enters into force, without having an authorised person to approve the promotion, they are likely to breach the Financial Promotion Restriction. In doing so, they will be committing a criminal offence that is punishable by up to two years' imprisonment, an unlimited fine, or both.
The FCA has made clear that it will take action against firms illegally promoting to UK consumers, including, but not limited to, placing firms on its Warning List and taking steps to remove or block any illegal financial promotions; such as websites, social media accounts and apps.
In certain cases, it will also consider enforcement action that may include applying to a Court for injunctions, seeking payment of compensation or, in the most serious cases, criminal prosecution. Given their close cooperation agreements with multiple global regulators, we expect the FCA will seek assistance from their counterparts in other jurisdictions where firms are illegally marketing into the UK.
Firms should also note that contracts entered into as a result of unlawful communications by them may be legally unenforceable against UK consumers.
The FCA has also been reminding businesses that support unregistered cryptoasset firms to carefully consider their obligations under the Proceeds of Crime Act 2002 (POCA) where they continue to assist firms which breach the Financial Promotions regime. Benefits obtained by unregistered cryptoasset businesses from illegal Financial Promotions could constitute criminal property, with businesses supporting unregistered cryptoasset firms potentially being at risk of committing money laundering offences under the POCA.
If you think your business is impacted or would like to discuss any of the incoming rules, please get in touch today by contacting Sushil Kuner in our Financial Services Regulatory team.
Footnotes
[] Financial Services and Markets Act 2000 (Financial Promotions) Order 2005
[] The Financial Services and Markets Act 2000
[] See letter dated 21 September 2023 from FCA to Cryptoasset Firms